Apple Earnings – Do They Mean Anything?

Apple (AAPL[1]) announces earnings on October 28 after the close, and now is the time to set up positions. The question is what to do, what to do?

Go long? Go short? Go for nothing?

The answer isn’t in the company’s numbers (they will be fine, not great) but in the Street’s view of the numbers and hopes for a strong forecast for iPhone 5 sales. The Street knows sales in August and September were artificially depressed due to the anticipation of the new product announcement and the lack of inventory in the channel before the quarter ended.

AAPL is likely to see e a very good fourth quarter, especially when Q4 is compared against the performance of other outfits already being hit by a sharp slowdown in consumer confidence. When consumers pull back, they focus on necessary products and on quality. The iPhone, for many, is both.

Back to “what to do”: my thought is to take advantage of the increase in volatility created by Washington and the increase in volatility due to the upcoming earnings announcement and sell some puts. Or if you own the shares, try some covered calls. I think this is a great set of choices because I believe the stock is fundamentally undervalued, I know most of you want to generate income and these are great, simple trades. If you do not believe the stock is worth $500…well, you are wrong.

As I write this and there is still a strong belief the crazies on Capitol Hill not force a default on U.S. debt, the stock is trading around $498. Consider one of two options (pardon the pun).

Buy the shares and sell the November $500 calls. You will get around $16.50 a contract. If you get called out you net 3.8% return in five weeks, a 38% annualized return.

Sell the November $500 put. You will get around $19.55 per contract, a return of 4.5% or a 45% annualized return.

Remember, there are now mini-put contracts available — they represent 10 shares, not 100.

What if the market craters? Of the stock craters? If you own the shares and have sold the calls (as I have), you buy back the calls and sell another one, generating more cash and averaging down the position. If you have sold puts you have done so in the belief the shares are worth $500 and you begin at a cost basis of $479.50 due to the cash you have collected when you sold the put. If the stock falls below the $500 level you either roll the position into a later week or month or you accept the shares and sell calls.

The bottom line: view AAPL as a block of capital you are using to generate income and be a long term investor in the stock itself.

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At the time of this writing Michael Shulman was long AAPL and had sold AAPL calls.